Ch. 5

Profit-Sharing Plan

A qualified defined contribution plan with discretionary employer contributions.

Primary Purpose of a Profit-Sharing Plan

Provide retirement savings through flexible employer contributions.

Profit-Sharing Plan Contribution Requirement

Contributions must be substantial and recurring.

Substantial and Recurring Rule

Commonly satisfied by contributions in at least 3 of 5 years.

Profit-Sharing Plan Funding

Fully discretionary.

Must Employer Have Profits to Contribute?

No.

Profit-Sharing Plan Classification

Defined contribution plan.

Investment Risk in Profit-Sharing Plans

Borne by the participant.

PBGC Coverage for Profit-Sharing Plans

Not covered by PBGC.

Participant Accounts in Profit-Sharing Plans

Separate individual participant accounts.

Prior Service Credit in Profit-Sharing Plans

Not permitted.

Types of Profit-Sharing Plans

Traditional Profit-Sharing, Stock Bonus, ESOP, and 401(k).

CODA

Cash or Deferred Arrangement permitting employee salary deferrals.

401(k) Plan

A CODA feature attached to a qualified profit-sharing plan.

Sources of Plan Contributions

Employer contributions, employee deferrals, matching contributions, forfeitures, QNECs, and QMACs.

Employer Contributions to Profit-Sharing Plans

Generally discretionary.

Employer Deduction Limit

25% of aggregate covered compensation.

2025 IRC 415(c) Annual Addition Limit

Lesser of 100% of compensation or $70,000.

Annual Addition Definition

Employer contributions, employee contributions, and allocated forfeitures.

Forfeiture

Nonvested employer contribution lost upon termination.

Uses of Forfeitures

Reduce employer costs or reallocate among participants.

Employee Contributions Vesting

Always 100% vested.

Employer Contributions Vesting

Typically 3-year cliff or 2-to-6-year graded.

Safe Harbor Employer Contributions Vesting

Immediate 100% vesting.

Standard Allocation Method

Allocates equal percentages of compensation to participants.

Standard Allocation Formula

Contribution rate multiplied by compensation.

Advantage of Standard Allocation

Simple and easy to administer.

Disadvantage of Standard Allocation

Does not favor owners or older participants.

Permitted Disparity

Social Security Integration used in defined contribution plans.

Purpose of Permitted Disparity

Provides larger allocations on compensation above the integration level.

Permitted Disparity Method

Excess Method only.

2025 Social Security Wage Base

$176,100.

Integration Level

Compensation level used to separate base contributions from excess contributions.

Base Contribution

Contribution applied to compensation up to the integration level.

Excess Contribution

Additional contribution applied above the integration level.

Reason for Permitted Disparity

Higher earners receive a lower percentage replacement from Social Security.

Age-Based Allocation Plan

A profit-sharing plan allocating larger contributions to older participants.

Age-Based Plan Objective

Provide more equivalent retirement benefits among participants.

Advantage of Age-Based Allocation

Favors older employees and owners.

Disadvantage of Age-Based Allocation

May appear inequitable to younger employees.

New Comparability Plan

A profit-sharing plan allocating contributions by employee classes.

Primary Goal of New Comparability

Maximize owner allocations while passing nondiscrimination testing.

Typical New Comparability Groups

Owner group and employee group.

Gateway Requirement Option One

Each NHCE receives at least 5% of compensation.

Gateway Requirement Option Two

NHCE allocation rate equals at least one-third of the highest HCE allocation rate.

Allocation Method Most Favorable to Owners

New Comparability.

Allocation Method Most Favorable to Older Employees

Age-Based Allocation.

Allocation Method Easiest to Explain

Standard Allocation.

When Defined Benefit Plans Become Attractive

When desired annual contributions exceed DC plan limits.

401(k) Plan Authority

IRC Section 401(k).